A financial bubble is a commonly used term that many people seem to hear now and then. But most of them may likely misunderstand what it means. In simple financial terms, a “bubble” is defined as a situation where a certain asset becomes highly inflated in terms of its price that seem to have little or no relation to its actual intrinsic value. Other terms may be used such as an “asset price bubble” or a “speculative bubble” aside from the term “financial bubble”. But they all refer to the same situation that usually happens now and then in various markets.

Characteristics Of A Bubble

There are ways to distinguish a financial bubble as it happens. There are certain characteristics that make a bubble what it is. One of the basic characteristics and probably the most common is the suspension of disbelief among most of the participants in a bubble phase. The said participants usually fail to recognize whether they and other traders may be engaged in a speculative exercise which lack considerable support from accepted valuation methods. It is also a common characteristic of bubbles that most participants are only able to recognize it after it happens or after the bubble has burst.

Dutch Tulip Bubble

The so-called Dutch Tulip Bubble in the 1630’s has become a prime example used always to gauge a bubble. It showed the extent of total disconnect that a price of a certain asset can have from its fundamental value. It may be the vivid colors as well as the lengthy years to grow tulips that seem to give them such high value. Its popularity rapidly increased among the Dutch in the 1600’s that eventually gained increased demand for the prized flower.

The Dutch Tulip mania and bubble stretched out as the demand for it grew. Tulip prices grew with the demand until it came into such a point of reaching outrageous proportions. Tulip customers grew increasingly willing to pay higher prices just to get hold of the tulips and contracts began selling for more than 10 times the annual income of skilled craftsmen. The peak of the tulip bubble was reached from 1636-37 where it eventually burst. With the collapse, tulip prices also tumbled down for up to a fraction of their peak prices.